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Working Paper, No. 2018-06, 2018 Crossref
News and Noise in the Post-Great Recession Recovery (Revised July 2018)

We develop and estimate a general equilibrium model to study the historical contribution of beliefs about future total factor productivity (TFP) to the U.S. business cycle. In the model, hiring frictions cause a temporary loss in firms’ efficiency because of recruiting and training activities. We show that such frictions induce firms to gradually hire more workers when they expect an improvement in future TFP. Using current and expected unemployment rates in estimation turns out to be crucial for identifying TFP news shocks, since periods in which the average unemployment rate is relatively high (low) are also periods in which average TFP growth is slow (fast). TFP news shocks cause fluctuations in beliefs about future TFP that mainly explain the trend unemployment rate. Yet, when we isolate those changes in beliefs that are orthogonal to TFP fundamentals, we find that these beliefs affect unemployment at business-cycle frequencies. After the Great Recession, these autonomous changes in beliefs have been the most important factor behind the rise in the employment rate and account for the labor market boom of 2014. The University of Michigan’s Index of Consumer Sentiment and the dismal TFP growth in recent years support this prediction.



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